Period  4Q14/FY14

Actual vs. Expectations  FY14 core net profit (CNP) of RM76.9m came in below expectations, making up 90% and 88% of our and consensus full-year FY14 net profit estimates, respectively.

 The negative variance was due to: lower-than-expected construction margins (16% vs our forecast’s 18%) following lower margins fetched in open tender projects coupled with higher operating costs.

Dividends  HSL declared a final DPS of 1.6 sen. Cumulatively, HSL has announced 2.8 sen DPS in FY14 (2.2% yield), below our DPS forecast of 4.0 sen.

Key Results Highlights

 4Q14 CNP fell 9% YoY and 6% QoQ dragged down mainly by lower construction margins. 4Q14 EBIT construction margin eroded significantly by 5ppts QoQ and 8ppts YoY to 13%.

 As a result of weaker construction margin, FY14 earnings declined by 10% which is the lowest construction margin achieved in ten years (FY14 EBIT Construction Margin: 16% vs FY13’s 20%). Management mentioned that the weak construction margins was due to: (i) lower profit margin from the projects that it secured via open tender, and (ii) general increase in cost of construction such as more expensive machineries (strong USD) and labor, and (iii) material delivery issues.  However, despite the group’s margins decline in FY14, it is still way above the industry average EBIT margin of 7%. Outlook  The group updated that it currently has about RM950m worth of outstanding orderbook, which provide earnings visibility for at least two years.

 Bright jobs replenishment prospects. We believe this year could be a big year for HSL as we understand that several high-profile projects in Sarawak are being rolled out. Among the projects are: (i) Phase 2 Kuching Centralised Wastewater System (RM700m), (ii) Pan-borneo highway (RM27b), and (iii) various infrastructure (road and water) projects in the SCORE area (Samalaju, Mukah, Tg Manis). Being a prominent contractor in Sarawak, we believe HSL is one of the prime beneficiaries of these projects.

Change to Forecasts  We take a cautious view by revising downward our FY15E earnings by 8.2% after seeing the group’s persistent margins compression in its construction segment. We are now assuming the group will fetch construction EBIT margins of 17% from 18% previously. We also introduced FY16E net profit of RM99.4m, representing a decent growth of 6.5%. Our forecasts are based on the assumption that the group will secure new RM600m new contracts per annum in FY15-16.

Rating Maintain OUTPERFORM Valuation  Despite weak margins recorded in FY14, HSL’s fundamentals are still strong i.e. still achieved one of the highest margins in construction space, strong balance sheet with net cash position (28.0 sen/share) and being one of the prime beneficiaries of the Sarawak’s infrastructure growth story.

 Post-earnings revision, we adjusted our Target Price to RM2.02 (from RM2.20 previously). Our TP is based on unchanged FY15PER of 12x in line with its mid-cap peers’ range of 12-14x.

Risks to Our Call  Failure to meet new contracts assumption.

 Higher-than-expected input costs.

 Slower-than-expected construction works progress

Source: Kenanga